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Financial strength score: the 9 tests of the Piotroski F-score

The Piotroski F-score in 9 tests: profitability, leverage, liquidity, efficiency. How to calculate it from two annual reports, usual thresholds, traps and the sectors excluded.

Published

Definition

The financial strength score, known as the Piotroski F-score, adds up 9 simple pass or fail tests, each worth one point. They compare the last two financial years on profitability, leverage, liquidity and efficiency. Published in 2000 by Joseph Piotroski, it aimed to separate, among companies priced low relative to their assets, those whose situation is improving from those that are deteriorating.

Formula

Score = number of tests passed out of 9 (one point per test: 4 for profitability, 3 for leverage and liquidity, 2 for efficiency)

Where to find it in an annual report

You need the last two annual reports, or one report that presents two financial years: the income statement (net income, gross margin, revenue), the balance sheet (total assets, long-term debt, current assets and liabilities, share capital) and the cash flow statement (operating cash flow). Some data sites calculate it directly.

Common thresholds

Value: 7 or more for green, 5 or 6 for orange, 4 or less for red. In the original study, scores of 8 and 9 mark the strongest companies and scores of 0 to 2 the most fragile. The score is designed for discounted companies: it says little about a growth company.

In the preset strategies

Preset strategy Criterion met To monitor Criterion not met
Value Financial strength score (out of 9) ≥ 7 5 to 7 < 5

Pitfalls

  • The score compares two years: an excellent, stable company can get an average score because nothing improves, even though nothing deteriorates.
  • The tests are binary: a gross margin moving from 40.0 to 40.1% counts as much as a ten-point rise.
  • An acquisition or a disposal changes the balance sheet and distorts several tests at once.
  • Data sites do not all apply exactly the same definitions: compare scores from the same source.

Where it does not apply

  • Banks and insurers: gross margin, the current ratio and long-term debt do not mean the same thing for them.
  • Young companies that are still loss-making: most profitability tests fail mechanically.

The 9 tests

Profitability

  1. Net income divided by total assets (return on assets) is positive.
  2. Operating cash flow is positive.
  3. Return on assets improves compared with the previous year.
  4. Operating cash flow exceeds net income.

Leverage and liquidity

  1. Long-term debt divided by total assets falls.
  2. The current ratio (current assets / current liabilities) improves.
  3. The company has not issued new shares during the year.

Efficiency

  1. Gross margin improves.
  2. Asset turnover (revenue / total assets) improves.

A worked example

A fictitious company, called Company AC here, passes tests 1, 2, 4, 5, 7 and 8. Its return on assets falls slightly, its current ratio too, and its asset turnover is flat. Its score is 6 out of 9: orange for the Value preset strategy. See also the value trap entry.

Sources